Inconsistent 'Analysis'
October 11, 2011
– Comments (7)
I personally am getting pretty tired of reading inconsistent economic and macroeconomic 'analysis'. The classic meaningless ratio that gets thrown around all the time (a la Reinhart and Rogoff) is National Debt / National GDP. The National Debt is a stock (number of dollars), The National GDP is a flow (number of dollars per time, such as quarters or years).
As I discuss here: Why Deficit Spending and Creative Destruction are not Mutually Exclusive Positions
A 'flow' is an economic quantity (in this post it is assumed that the quantity is in terms of US Dollars) measured over a unit of time. For example GDP is a flow (the net economic activity generated in a quarter or a year). The US Budget deficit is a flow (how much the Federal Government spends more than it taxes over a year).
A 'stock' is an economic quantity (again in terms of Dollars). The US National Debt is a stock.
'Flows' accumulate to 'Stocks'. At the end of a measurement period, the US Budget Deficit accumulates to the National Debt.
You cannot compare stocks and flows in any meaningful way. You compare stocks against stocks, you compare flows against flows. These both give ratios. But comparing stocks and flows gives you a number in units of time. For example: The US National Debt (say $50 Trillion) / The US GDP (say $10 Trillion/yr) gives you a result of 5 years. This is not a meaningful metric, because it has no context.
When 'anlaysts' start ratioing stocks and flows, such as David Brooks does in the article below, it pays to put on a A Decent Macroeconomic Filter
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Bathtubs for Beginners
By James Kwak
http://baselinescenario.com/2011/10/11/bathtubs-for-beginners/
In economics life there’s a basic conceptual distinction between a flow and a stock. A flow is a something that occurs over some period of time, like water pouring from a faucet into a bathtub. A stock is something that exists at a specific moment of time, like the water in that bathtub. You measure a flow over a period of time (e.g., gallons per minute); you measure a stock at a specific moment in time (e.g., gallons). For a business, the income statement (revenues and costs in a year) measures flows, while the balance sheet (assets and liabilities) measures a stock. That’s why the income statement is dated for a year (or a quarter) and the balance sheet is dated for a specific day. Everyone understands this. If you didn’t, you would get confused between your salary and your bank account.
But not David Brooks.
In today’s self-indulgently contrarian column, Brooks argues that the Occupy Wall Street movement is made up of “small thinkers.” Here’s his evidence:
“They will have no realistic proposal to reduce the debt or sustain the welfare state. Even if you tax away 50 percent of the income of those making between $1 million and $10 million, you only reduce the national debt by 1 percent, according to the Tax Foundation. If you confiscate all the income of those making more than $10 million, you reduce the debt by 2 percent. You would still be nibbling only meekly around the edges.”
This is incoherent to begin with. Tax policy directly affects flows, not stocks, so its impact on the national debt (a stock) is indeterminate unless you specify a length of time for the policy to be in place.
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